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Trading Strategies Trading Strategies

(“(“Picking the Equity Players”, chapter 10 in Strong) chapter 10 in Strong)

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Stock Selection PhilosophyStock Selection Philosophy

Fundamental analysis Technical analysis

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Fundamental AnalysisFundamental Analysis

A fundamental analyst tries to discern the logical worth of a security based on its anticipated earnings stream

The fundamental analyst considers:- Financial statements- Industry conditions- Prospects for the economy- Etc.

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Technical AnalysisTechnical Analysis

A technical analyst attempts to predict the supply and demand for a stock by observing the past series of stock prices

Financial statements and market conditions are of secondary importance to the technical analyst

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Types of DividendsTypes of Dividends Cash dividends Stock dividends Spin-offs Rights

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Cash DividendsCash Dividends Cash dividends are distributions of the firm’s profits to the

shareholders paid via a check from the company Cash dividends can sometimes be reinvested via dividend

reinvestment plans (DRIPs)

- Sometimes allow for purchase of additional company shares at a discount

If shares are held in street name:

- The brokerage firm receives the dividend check

- The brokerage firm ultimately allocates dividends to the shareholders

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Stock DividendsStock Dividends Stock dividends are paid in additional shares of stock

rather than in cash Typically announced as a percentage

- E.g., 10 percent stock dividends Popular when a firm lacks the funds to pay a cash dividend Popular early in the firm’s life cycle

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Spin-OffsSpin-Offs In a spin-off, a parent firm divests itself of a subsidiary

and distributes all shares in the subsidiary proportionally to the parent firm’s shareholders

The parent gives away the subsidiary

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RightsRights The preemptive right means shareholders have the ability

to maintain the same percentage share of ownership in a corporation when the firm sells new shares

Existing shareholders can buy new stock at a discount from market price

Rights are actual securities that shareholders can buy or sell

Rights have a limited life

- Usually expire a few weeks after issued

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Chronology of EventsChronology of Events Date of declaration

- The day the board announces the dividend

- Once declared, the dividend becomes a legal liability of the company

Date of payment

- The company mails dividend checks Date of record

- Establishes who will receive dividend checks

- Shareholders of record are listed on the company records as being owners of the company on the date of record

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Ex-dividend dateTwo business days prior to the date of recordIf you buy the stock before the ex-dividend date, you will get the

next dividendIf you buy the stock on the ex-dividend date, you will not get the

next dividendEliminates any ambiguity about who is entitled to the dividend

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Why Dividends Do Not Matter?Why Dividends Do Not Matter? Payment of dividends reduces the balance in the firm’s

cash account- The firm should not be worth as much after paying a

dividend

The ex-dividend date determines whether or not you get the dividend- On the ex-dividend date, the price of a share of stock

tends to fall by about the amount of the dividend to be paid

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Why dividend policy matters?Why dividend policy matters? Most firms increase their dividend annually, and the

market expects this- If management does not increase the dividend as

expected, the market views it as bad news Reducing or omitting a dividend is a very bad signal An increase in dividends above what the market expects is

a good signal

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Stock SplitsStock Splits

A stock split occurs when a firm changes the number of shares of its capital stock without changing the aggregate value of these shares

A stock split is generally a neutral occurrence

- The primary motivation is to reduce the price of shares to bring it into an optimal trading range

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Why Firms Split Their StockWhy Firms Split Their Stock Some literature supports the existence of an optimal trading

range

- A principal reason for splitting shares is “to broaden the ownership base”

Reverse splits are sometimes used to reduce the number of shareholders

- E.g., a 1-for-200 splits eliminates all shareholders holding fewer than 200 shares

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Value investingValue investing Value investors look for undervalued stock

Value investors look for low price/ earnings and price/book ratios

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Growth InvestingGrowth Investing

Growth investors look for price momentum

- Look for stocks that are in favor and have been advancing

- Look for stocks that are likely to be propelled even higher

- Normally, they invest in stocks with high P/E and P/B ratios

The market moves in cycles

- Many investors own both growth and value stocks

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CapitalizationCapitalization Capitalization refers to the aggregate value of a company’s

common stock Typical divisions are:

- Large cap ($10 billion or more)- Mid-cap (between $500 million and $10 billion)- Small cap (less than $500 million)

Many money managers distribute their assets across size and style spectrums

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Categories of StockCategories of Stock Blue chip stock Income stocks Cyclical stocks Defensive stocks Growth stocks Speculative stocks Penny stocks

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Blue Chip StockBlue Chip Stock

Blue chip has become a colloquial term meaning “high quality”- Some define blue chips as firms with a long,

uninterrupted history of dividend payments- The term blue chip lacks precise meaning, but some

examples are:Coca-ColaUnion PacificGeneral Mills

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Income StocksIncome Stocks Income stocks are those that historically have paid a

larger-than-average percentage of their net income as dividends- The proportion of net income paid out as dividends is

the payout ratio- The proportion of net income retained is the retention

ratio

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Cyclical StocksCyclical Stocks Cyclical stocks are stocks whose fortunes are directly tied

to the state of the overall national economy

Examples include steel companies, industrial chemical firms, and automobile producers

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Defensive StocksDefensive Stocks Defensive stocks are the opposite of cyclical stocks

- They are largely immune to changes in the macroeconomy and have low betas

Examples include retail food chains, tobacco and alcohol firms, and utilities

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Speculative StocksSpeculative Stocks Speculative stocks are those that have the potential to

make their owners rich quickly Speculative stocks carry an above-average level of risk Most speculative stocks are relatively new companies with

representation in the technology, bioresearch, and pharmaceutical industries

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Penny StocksPenny Stocks Penny stocks are inexpensive shares

Penny stocks sell for $1 per share or less

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Learning outcomes:• Know what are the fundamental and technical analyses• Know about cash and stock dividends; spin-offs and rights • Comment on the following statement: Dividends do matter; it is dividend policy that does not matter.• Discuss the four dates in the life of a dividend payment• Know about stock splits;• Explain the differences between value and growth investing.• Discuss the categories of stock mentioned in this slides.